MNI INTERVIEW: Last Thing BOC Wants Is Cut And U-Turn- Stillo
Credibility has been strained in recent years by policy shifts, former Ontario government forecaster says.
The Bank of Canada will resist cutting rates until mid-year even as a mild recession takes hold in case sustained inflationary pressures in areas such as housing force another change of course, an ex-forecasting manager for the country's largest province told MNI's FedSpeak podcast.
“They will proceed cautiously because they are still worried that inflation and inflationary expectations could get stuck above their target, and let’s face it, they don’t want to reverse course later,” said Tony Stillo, Canada Director at Oxford Economics and formerly at Ontario’s finance ministry. “The last thing they want to do with the credibility issues they’ve had over the last couple of years is to reverse course.”
The Bank can start easing when core inflation slows to about 2.5% according to Stillo, who sees three cuts taking the overnight lending rate to 4.25% this year, with the first coming in June. Most investors see rates falling around the middle of the year but several pick April as the starting date.
Governor Tiff Macklem on Wednesday kept the benchmark rate at 5%, the highest since 2001, even as politicians and the public decry the pain of high inflation and interest rates stalling the economy. Officials have been forced to defend earlier policy shifts including ten hikes after saying borrowing costs would remain near zero for some time in the wake of the pandemic and then flagging a pause early last year only to hike twice more several months later.
BIG HOUSING WEDGE
Macklem last week said another rate hike can't be ruled out with inflation having been above target for so long and core prices slow to unwind, though a debate about cuts could emerge when it's clear price stability is being restored. Core inflation is running around 3.5%, outside the Bank's 1% to 3% target band for headline prices and the official target of 2%.
Canada's housing market, deemed by the IMF as one of the most overstretched in the world, is a key reason for waiting longer to ease according to Stillo. Inflation is 3.4% and about a percentage point of that is from shelter costs. (See MNI INTERVIEW: Peaking BOC Rate Rekindles Housing-Royal LePage)
“There’s a big wedge in there and the Bank of Canada has apprehensions about that shelter inflation, for sure,” he said.
Also on the Bank's mind are elevated wage gains and conflicts such as in the Red Sea that could disrupt supply networks, Stillo said. Such risks will keep borrowing costs well above normal, he said.
“They aren’t going to cut rates back down to neutral,” a level which Stillo sees at 2.25% versus the Bank's estimate of between 2% and 3%. (See MNI INTERVIEW: BOC Keeping 2024 Policy Restrictive- CD Howe)
HATE TO LOSE
“Wages are still growing well above that sort of sweet spot” of around 3% that would be more closely tied to worker productivity and the Bank’s 2% inflation goal, he said. “They would like to see that come down.”
Borrowing costs will remain restrictive even with signs the economy entered recession in the third quarter, Stillo said. The downturn will be mild with output declining by perhaps 1% but the drag is much worse on a per capita basis when you strip out record immigration, he said.
“We’re in the hard landing” camp, he said, because “the economy is very interest-sensitive, people have a high level of indebtedness.” Consumer debts outgrew GDP years ago and there is a segment of households with large mortgages coming up for renewal at much higher rates.
One lesson that may have been overlooked through the era of low-for-long rates is that the Bank has less tolerance for above-target inflation, another reason Stillo said officials will err on the side of slower cuts. He has modeled out a scenario where inflation remains sticky and found the Bank could be forced to hike rates twice more.
While Macklem has signaled another hike is growing unlikely, Stillo agrees this cannot be ruled out. “They have an asymmetric loss function. They will always be more concerned about higher inflation.”